TIME TO JUNK THE CORPORATE TAX

May 6, 2010

President Obama has put tax reform on the agenda, but surprisingly little attention is being paid to fixing the most growth-inhibiting, anticompetitive tax of all: the corporate income tax. Reducing or eliminating the corporate tax would curtail numerous wasteful tax distortions, boost growth in both the short and long run, increase America's global competitiveness, and raise future wages, says Michael J. Boskin, a professor of economics at Stanford University and a senior fellow at the Hoover Institution.

The United States has the second-highest corporate income tax rate of any advanced economy (39 percent including state taxes, 50 percent higher than the Organization for Economic Co-operation and Development (OECD) average).

Many major competitors, Germany and Canada among them, have reduced their corporate tax rate, rendering American companies less competitive globally.

Of course, various credits and deductions -- such as for depreciation and interest -- reduce the effective corporate tax rate. But netting everything, our corporate tax severely retards and misaligns investment, problems that will only get worse as more and more capital becomes internationally mobile. Corporate income is taxed a second time at the personal level as dividends or those capital gains attributable to reinvestment of the retained earnings of the corporation. Between the new taxes in the health reform law and the expiration of the Bush tax cuts, these rates are soon set to explode, says Boskin.

This complex array of taxes on corporate income produces a series of biases and distortions, the most important is the bias against capital formation, decreasing the overall level of investment and therefore future labor productivity and wages, says Boskin.

Reducing or eliminating the negative effects of the corporate tax on investment would increase real gross domestic product and future wages significantly, says Boskin. Junking both the corporate and personal income taxes and replacing them with a broad revenue-neutral consumption tax would produce even larger gains. Nobel Laureate Robert Lucas concluded that implementing such reforms would deliver great benefits at little cost, making it "the largest genuinely true free lunch I have seen."